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Unformatted text preview: Click to edit Master subtitle style Aggregate Supply Tradeoff Between Inflation and Unemployment Topics two models of aggregate supply in which output depends positively on the price level in the short run about the shortrun tradeoff between inflation and unemployment known as the Phillips curve Introduction In previous chapters, we assumed the price level P was stuck in the short run. This implies a horizontal SRAS curve. Now, we consider two prominent models of aggregate supply in the short run: Stickyprice model Imperfectinformation model Introduction Both models imply: ( ) Y Y P EP = + natural rate of output a positive parameter expected price level actual price level agg. output Other things equal, Y and P are positively related, so the SRAS curve is upward sloping. The stickyprice model Reasons for sticky prices: longterm contracts between firms and customers menu costs firms not wishing to annoy customers with frequent price changes Assumption: Firms set their own prices ( e.g. , as in monopolistic competition). The stickyprice model An individual firms desired price where a > 0. Suppose two types of firms: firms with flexible prices, set prices as above firms with sticky prices, must set their price before they know how P and Y will turn out: p P a Y Y = + ( ) p EP a EY EY = + ( ) The stickyprice model Assume sticky price firms expect that output will equal its natural rate. Then, To derive the aggregate supply curve, first find an expression for the overall price level. s = fraction of firms with sticky prices. Then, we can write the overall price level as O bj1 0 3 = p EP The stickyprice model Subtract (1 & s ) P from both sides: price set by flexible price firms price set by sticky price firms Divide both sides by s : 1 = + + [ ] ( )[ ( )] P s EP s P a Y Y 1 = + [ ] ( )[ ( )] sP s EP s a Y Y 1 = + ( ) ( ) s a P EP Y Y s The stickyprice model High EP High P If firms expect high prices, then firms that must set prices in advance will set them high. Other firms respond by setting high prices. High Y High P When income is high, the demand for goods is high. Firms with flexible prices set high prices....
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This note was uploaded on 02/05/2011 for the course BUAD 500 taught by Professor Wilson during the Spring '11 term at William & Mary.
 Spring '11
 Wilson
 Inflation, Unemployment

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